Nevada’s Supreme Court and the Ninth Circuit are at Odds on Fundamental Questions of Federalism.

Recently, the Nevada Supreme Court and United States Court of Appeals for the Ninth Circuit (the “Ninth Circuit”) reached opposing conclusions on the same issue of Nevada law. As has been noted in the past,[1] Nevada’s Supreme Court does not hesitate to distinguish itself from other federal courts and their holdings. The latest major juncture in this dispute finds the Nevada Supreme Court disagreeing with the Ninth Circuit in a manner that could raise profound constitutional issues and require the United States Supreme Court’s intervention to resolve.

For real estate litigation cognoscenti, it is no surprise that the crux of this problem arises from the super-priority liens created by NRS 116.3116 et seq., which historically gave homeowners associations (“HOA’s”) a super-priority interest in the most recent nine months’ worth of HOA dues.[2] Following the economic turmoil of 2008 through 2009, HOA’s sold these liens to the highest bidders, who in turn would commence non-judicial foreclosing proceedings based on possessing a super-priority interest in the property by purchasing the interest created by the overdue HOA dues. Investors savvy to this process were able to purchase single family homes—frequently in highly desirable areas—for thousands of dollars.

Litigation ensued. Banks, incredulous that NRS 116.3116 and its super-priority extinguished its much larger deed of trust interests on the houses, took to the courts arguing that the super-priority lien did not operate as it was being applied. To the banks, the super-priority liens created, at best, an equitable entitlement to first satisfy the delinquent HOA dues from the proceeds of a foreclosure sale performed by the holder of a first deed of trust—it did not extinguish the deed of trust entirely. The Nevada Supreme Court, however, saw it otherwise. In 2014, the Nevada Supreme Court ruled in SFR Investments Pool 1 LLC v. U.S. Bank N.A. that the plain language of NRS 116.3116 did create a true super-priority lien in the overdue HOA dues, and one that would extinguish even a bank’s deed of trust in the property.[3]

More litigation ensued. In late 2016, a permutation of the super-priority lien issue made its way before the Ninth Circuit.[4] Rather than address the operation and true intent of NRS 116.3116, which the Nevada Supreme Court had spoken to in SFR and its lineage of related cases, the Ninth Circuit took a different approach. The appeals court found NRS 116.3116(2) to be facially unconstitutional, constituting an impermissible state action requiring lenders to protect themselves against loss—despite holding deeds of trust—by requesting notice from HOA’s of their intended foreclosure on their super-priority liens.[5] As a result, Nevada’s super-priority scheme resulted in a violation of the lender’s due process rights.[6] For a moment, at least in federal court, the super-priority was dead.

This death of the super-priority lien was short-lived. In January of 2017, the Nevada Supreme Court directly addressed the Bourne Valley decision in Saticoy Bay LLC Series 350 Durango 104 v. Wells Fargo Home Mortgage, and expressly “declin[ed] to follow” the Ninth Circuit’s holding.[7] The Nevada Supreme Court’s position, and interpretation of state law, undermined the premise of the Ninth Circuit’s opinion: That non-judicial foreclosure of an HOA lien involves state action and implicates the due process clause of the United States Constitution. “[D]ue process is not implicated in an HOA’s nonjudicial foreclosure,” wrote the Nevada Supreme Court, going on to explain in detail why the super-priority lien’s extinguishment of subordinate interests, including deeds of trust held by national banks, did not constitute a government taking.[8]

The tension between the Ninth Circuit and Nevada Supreme Court creates a potential mess of federalism. Under the Erie doctrine, federal courts that have based their jurisdiction on diversity (i.e., the amount in controversy and differing citizenship of the parties, rather than purely federal questions such as patent infringement or qui tam actions under the federal false claims act) are compelled to follow state law.[9] Ultimately, states have the final determination of what their law actually is, whether through the judiciary or the legislature. On questions of federal law, though, federal courts have the final say, for reasons traced directly back to the Supremacy Clause of the United States Constitution.

The latest phase of the super-priority lien fight is less of a fight about the law’s meaning than whether or not it implicates rights arising under the United States Constitution. The Ninth Circuit’s opinion in Bourne Valley contends that it does, and the statute on its very face violates the due process clause of the Fourteenth Amendment.[10] Nevada’s Supreme Court, arguably making the dispute a matter wholly of state law and therefore beyond the United States Supreme Court’s reach, reasoned that super-priority foreclosures did not implicate the due process clauses of either the United States or Nevada Constitutions.[11]

The Nevada Supreme Court’s self-differentiation from other federal courts is not some quirk of local law. Despite the ever-broadening sweep of federal law,[12] the United States Supreme Court recognized within the last 100 years that it was “one of the happy incidents of the federal system” that a single state may “serve as a laboratory; and try novel social and economic experiments without risk to the rest of the country.”[13] As seen in the ongoing super-priority lien battles, and the Nevada Supreme Court’s general support for enforcing the Nevada statute as written in prior decisions, its distinctiveness can have far-reaching implications and set the stage for larger battles. While the likelihood of any particular case being heard by the United States Supreme Court is slim, the question of whether a state can determine whether or not its own laws implicate constitutional rights is one that the justices may select for review.

[9] Federal courts are, however, allowed to make certain predictions regarding how state courts would rule on issues where there is no direct precedent; federal courts also have the option to certify questions of state law to the Nevada Supreme Court for its consideration under Nevada Rule of Appellate Procedure 5.

The Copyright Act of 1976 broadly allows for original works “fixed in any tangible medium of expression” to by copyrighted. 17 U.S.C. § 102. Registering the copyright for a creation allows the copyright owner to bring suit – for up to $150,000 in some cases – and use a wide range of other remedies provided in the Copyright Act.

However, the Copyright Act throws the brakes on copyright protection for sculptures and other graphic works. In its definition of “pictorial, graphic, and sculptural works,” the Copyright Act excludes objects it considers to be “useful articles”:

the design of a useful article, as defined in this section, shall be considered a pictorial, graphic, or sculptural work only if, and only to the extent that, such design incorporates pictorial, graphic, or sculptural features that can be identified separately from, and are capable of existing independently of, the utilitarian aspects of the article.

A “useful article” is an article having an intrinsic utilitarian function that is not merely to portray the appearance of the article or to convey information. An article that is normally a part of a useful article is considered a “useful article”.

Is a hookah a useful article? In Inhale Incorporated v. Starbuzz Tobacco, Incorporated, the United States Court of Appeals for the Ninth Circuit said no—but with some caveats. 755 F.3d 1038, (9th Cir. 2014). In that case, both parties agreed that the plaintiff-appellant’s hookah was a useful article. The only question was whether the shape of the container was conceptually separable from its function as a hookah.

The Ninth Circuit held that the hookah’s shape was not independent of its function – to hold water within the shape of the container. As a result, the appeals court affirmed the district court’s decision, finding that the hookah was not copyrightable. The Ninth Circuit broadly stated its holding thusly: “any part of a container that merely accomplishes the containing is not copyrightable.” If some element of the design extended beyond merely holding water—fulfilling the hookah’s functional purpose—the outcome may well have been different.

The Ninth Circuit took great pains to point out that the images applied to the outside of the hookah were copyrightable. The panel even disclaimed that its opinion “should not be understood to affect the copyrightability of” pictorial, graphic, or sculptural works under 17 U.S.C. § 101. It was the design of the hookah itself, rather than the images adorning it, that gave rise to the dispute.

Two other notable things about this opinion: First, the Ninth Circuit affirmed the district court’s award of $111,993 in attorney’s fees to Starbuzz Tobacco under 17 U.S.C. § 505. Then, the Ninth Circuit went on to award Starbuzz with fees incurred in the defense of Inhale’s appeal under the same statute. The amount of fees awarded is not specified in the order. However, in May 2013, United States District Court Judge Otis Wright estimated that the cost of an effective appeal to the Ninth Circuit was a little more than $80,000 (see fn. 5). Ouch.

Second, there’s a point of resistance in Justice Bea’s separate concurrence about the deference the Ninth Circuit owes to the Copyright Office’s interpretation of the Copyright Act. The panel relied on the Compendium of Copyright Office Practices II and an opinion letter from the Copyright Office in guiding their interpretation of 17 U.S.C. § 101. Justice Bea, however, contended that the statute is not ambiguous, and reliance on the Copyright Office’s interpretation of the statute is misplaced.

While the opinion does not require other courts to look to the Copyright Office when interpreting the Copyright Act in the future, Justice Bea’s desire to protect the sovereignty of the federal courts is understandable. While administrative records can be helpful to the courts, especially in resolving ambiguity, one can understand why a judge with lifetime tenure would want to resist being bound by them.

The Federal Trade Commission (“FTC”) is the federal government’s arm to oversee and regulate marketing practices. The good news, depending on how you look at it, is that the FTC has no criminal authority. The FTC does, however, come after the money of businesses large and small, both highly visible and operating in the shadows.

The Court of Appeals for the Ninth Circuit’s decision in FTC v. Grant Connect, LLC, 763 F.3d 1094 (9th Cir. 2014), an appeal from the United States District Court for the District of Nevada, provides an overview of how the FTC operates against individuals and their many companies. Based on the opinion, the FTC has a lengthy history with Kyle Kimoto and various companies he operated, including a prior legal skirmish before the Seventh Circuit.

The FTC did not target Kimoto and his company in the Ninth Circuit case, Grant Connect LLC, out of the blue. Instead, the FTC had had Kimoto and his companies under its scrutiny “for over a decade,” resulting in three distinct enforcement actions. The Ninth Circuit’s decision represented just the culmination of the latest action.

Prelude to the Ninth Circuit’s Decision

In 2003, the FTC sued Kimoto and one of his companies, Assail, Incorporated, alleging that the company offered customers pre-approved MasterCard credit cards, but would give them applications for cash-secured debit cards or unusable plastic cards. This scheme apparently was quite successful: the district court in that case ordered Kimoto to pay $106 million in restitution. Based on his actions with Assail, the FTC even initiated criminal charges against Kimoto – the FTC’s second front against his conduct.

According to the Ninth Circuit’s opinion, Kimoto then moved to Las Vegas to pursue new Internet marketing activities. Kimoto organized a company, Vertek Group LLC, under his then-wife’s ownership in order to “avoid regulatory scrutiny.” (Ninth Circuit’s words, not mine.)

As is often the case in these cases, the new company uses the same old players. Kimoto was responsible for much of Vertek Group LLC’s operations. Among the people he hired to help him were two former employees of Assail Incorporated. Having reunited the band, Kimoto recommenced his activity offering unsecured lines of credit using a new entity, and a new legal front for the business – his former wife.

How the Business Worked

The Ninth Circuit describes Vertek’s conduct as being typical of questionable Internet sales operations. While Vertek did disclose details for the limited offer, they were placed in small type below the field where a visitor would submit his or her application for Vertek’s offer. This text contained a number of surprising terms, including that customers would be charged $39.95 per month if they did not cancel the service, that they would automatically be signed up for additional services, and they would be billed for these additional services in the future. Most surprising, though, is what the scheme’s victims actually received. Vertek’s customers believed they would be receiving a credit card. Instead, they received a line of credit that could be used only to purchase merchandise from Vertek’s website.

The FTC shut down Vertek’s operations in 2009. In its nearly two years of operations, 94% of subscribers cancelled their subscription to the site’s services – but not without considerable effort on their part.

However, Vertek’s line of credit offer was not the only scheme Kimoto operated during this time. The government’s name defendant, Grant Connect LLC, was Kimoto’s company – organized in a manner similar to Vertek Group LLC – used to sell access to putative government grants. From the Ninth Circuit:

“The Grant Connect landing pages featured pictures of President Obama and Vice President Biden, or of a scantily clad female holding cash.”

One of these things is not like the other. Nonetheless, people signed up for it—paying an initial $2.78 processing fee, and then being charged $39.95 per month for the grant service, in addition to being involuntarily added to other services with recurring fees. Like Vertek’s scheme, 91% of subscribers cancelled their memberships by the time the FTC shut down the operation in May 2009. In reality, the government grants that Grant Connect marketed “cannot be used for personal expenses,” and did not exist for the purposes Grant Connect promoted.

Kimoto and his companies were involved with still more contemporaneously operating schemes. In addition to a work-from-home scheme similar to those already discussed, Vertek was also involved with a scheme based on the sale of Acai berries for fat loss and anti-aging purposes. Ultimately, the FTC shut down all of these operations.

Whither Personal Liability for Ostensibly Corporate Acts?

While the companies’ violations of the FTC Act were largely undisputed, a question arose as to whether Kimoto was personally liable for those violations. The Ninth Circuit quickly dispatched with this argument, though, pointing out that 15 U.S.C. § 1693o(c) makes any violation of the Electronic Fund Transfer Act (EFTA) a violation of the FTC Act. The very nature of the EFTA required the FTC to enforce it. The Ninth Circuit’s reasoning then incorporated portions of the FTC Act in interpreting the enforcement of penalties under the EFTA. Just as the FTC Act allows for a company’s principals to be personally liable for violations of the act, the EFTA can reach the same result because violations of its provisions are deemed to also contravene the FTC Act. Additionally, the court found that Kimoto’s actions in operating the companies provided an ample basis for his personal liability.

Finally, the Ninth Circuit upheld the District of Nevada’s injunction as necessary to prevent Kimoto from engaging in further unlawful conduct. Because Kimoto was the common element in all of his companies’ unlawful activities, the district court’s injunction against him engaging in any electronic fund transfers in the future was proper. This decision was buttressed by evidence of Kimoto’s history of operating similar scams across a web of companies in the past. Despite the injunction’s wide breadth, the Ninth Circuit refused to find it was overbroad in its scope.

The takeaway from this decision is that the FTC’s powers are broad and manifold. The commission may raise its head in enforcing laws that are not part of the FTC Act, and that may not even be clearly connected to the FTC. (Recall that the Secret Service has some authority over monetary issues, and money laundering generally falls under the FBI’s purview.) When the FTC chooses to act, it is with crushing finality. While Kimoto’s actions are despicable, they warranted the imposition of a very broad permanent injunction – one that even the Ninth Circuit upheld.

Thus, the lack of criminal authority and the ability to put bad actors in jail has not done much to impede the FTC’s power. Although the FTC’s power was put to good use in this case, it should be a chilling reminder to those who do business online that the FTC’s rules regulations extend to affiliate links and even promotional SMS messaging, making it a power for anyone to fear.

In Part 1, we examined the rise of class action lawsuits over protein supplement manufacturers. Recently, the United States Court of Appeals for the Ninth Circuit held that inaccurate food labels could be subject to state law claims, as the Food, Drug, and Cosmetic Act (“FDCA”) did not preempt those claims. This issue is of importance in the pending consumer litigation against Quest Nutrition and the manufacturer of Body Fortress protein powder.

Consumers are not the only group with a potential right of action against manufacturers who are spiking their protein with amino acids. The Lanham Act allows one competitor to sue another for making false and misleading statements or descriptions about the contents or nature of its goods. 15 U.S.C. § 1125(a).

For example, company A is selling 100% pure whey protein at about $11 a pound. On its packaging, it proudly – and truthfully – states that it is selling 100% whey protein. Company B is also selling a product it labels as 100% whey protein, but it’s actually only about 80% protein – the other 20% is made up of cheap amino acids. This allows Company B to sell a product it claims is 100% whey protein (but isn’t) for a price 20% lower than Company A.

Under 15 U.S.C. § 1125, Company A could sue Company B for unfair competition. In the past, companies in the position of Company B have claimed that unfair competition claims over their labeling fall under the FDCA and are within the exclusive jurisdiction of the Food and Drug Administration. That is, until June of 2014, when the Supreme Court decided that hypothetical Company B’s argument was wrong – the FDCA would not preclude a Lanham Act claim for unfair competition.

Pom Wonderful LLC v. Coca-Cola Company grappled with the same issue underlying protein spiking. Pom Wonderful creates and markets a variety of pomegranate-based products under its ubiquitous POM label. Coca-Cola is the owner of Minute-Maid, a juice company that made a “pomegranate blueberry” juice. In reality, Coca-Cola’s offering was 0.3% pomegranate juice, 0.2% blueberry juice, and 99.4% apple and grape juice. Nonetheless, Coca-Cola gave the words “pomegranate” and “blueberry” particular significance on the juice’s label.

Pom sued Coca-Cola for unfair competition under 15 U.S.C. § 1125. Pom argued that Coca-Cola’s labeling created the impression that its primary ingredients were pomegranate and blueberry, when the reality was quite the opposite. The United States District Court for the Central District of California rejected Pom’s argument, though, stating that the FDCA precluded a challenge to the accuracy of Coca-Cola’s labeling. The Ninth Circuit upheld the District Court’s ruling to that end, finding that Pom’s grievance was an issue for the FDA to address, rather than Pom.

The Supreme Court quickly dispatched with that reasoning. The court plainly stated that Pom “is not a pre-emption case.” Instead, the Supreme Court found that neither the FDCA nor the Lanham Act–both federal statutes–limit or preclude the Lanham Act’s application issues governed by the FDCA. Instead, the court found the Lanham Act and FDCA to “complement each other,” and that the FDCA did not create any express or implied bar to a Lanham Act claim.

So what does it all mean?

Company A, who is selling 100% whey protein as it claims, can smack Company B with a lawsuit and correct the marketplace. Company B would be left with a number of unpleasant options: also sell 100% protein, thus losing the cost advantage it obtained by diluting its product; admit that its product is not 100% protein; or exit the marketplace. Because Companies A and B are competitors, the Lanham Act would allow Company A to bring the suit, rather than consumers.

However, if the suit brought about any changes to Company B’s behavior, it would result in a number of gains for consumers: better quality products, more accurate labeling, and increased marketplace knowledge of what Company B is actually selling.

To see the Supreme Court explain it, it seems almost obvious that the FDCA would never bar a Lanham Act claim. Yet the trial court and even the court of appeals, which both believed that the FDCA barred the claim, had to stand corrected. Now that the issue is settled, it may be easier for supplement companies to go to court against their less scrupulous rivals.

For a different take on the Pom Wonderful decision, and how it may persuade you to make your own juices at home, check out this post from Fit-Juice.

2014 saw a rise in consumer lawsuits against makers and distributors of protein supplements. Protein’s benefits are well-documented, as it is integral to muscle growth and helpful in fat loss, as seen in the popularity of the Atkins, Paleo, Primal, and other protein-heavy diets. It is also expensive when compared to other macronutrients – fat and carbohydrates.

In January 2014, Jamie Lewis of Chaos and Pain did his own research and outed companies he accused of “spiking” their protein with amino acids. Based on Lewis’ findings, many companies are diluting their protein with amino acids while charging the consumer for unadulterated product.

First, how is this possible? The general test for evaluating the contents and purity of protein powders examines the total nitrogen within the supplement. Like proteins, amino acids are full of nitrogen – adding them in can increase the supplement’s nitrogen readings, making it appear to be loaded with protein even while its actual protein content is lacking. This also saves manufacturers money, as protein is more expensive than amino acids.

Second, what’s the difference between amino acids and protein? Isn’t protein just a string of amino acids? Yes; that foggy recollection of high school biology is scientifically accurate, but missing key details. Proteins are made up of amino acids, but the amino acids used to spike protein – glycine and taurine – do not come close to delivering the benefits of whole protein.

The end result is paying for four or five pounds of protein, but getting appreciably less than that – and a bunch of cheaper, less-effective amino acids in its place. Think of it as paying for filet mignon, then finding the middle of your filet hollowed out and stuffed with ground beef. For car people, it’s like buying a 3-series and discovering that the BMW engine was swapped out for a Yugo. However you look at it, it’s bad.

There ought to be a law…

The Federal Food, Drug, and Cosmetics Act (“FDCA”), 21 U.S.C. § 301, governs the labeling of food and drugs, among other items. In 1990, Congress enacted the Nutrition Labeling and Education Act, creating uniform food-labeling requirements in the form of the familiar Nutrition Facts Panel. Although dietary supplements – as defined in the FDCA – are generally unregulated, they are subject to the Nutrition Labeling and Education Act’s requirement of bearing a Nutrition Facts Panel. See 21 U.S.C. § 343(s).

Despite the law’s requirements, consumers face an obstacle. The FDA generally has exclusive jurisdiction over enforcement of the FDCA. In fact, the Nutrition Labeling and Education Act prohibited states from adding additional requirements to these labels. 21 U.S.C. § 343-1. Consumers’ only option was to file their own lawsuits – lawsuits that manufacturers typically claimed federal law preempted.

That preemption argument failed earlier this year before the United States Court of Appeals for the Ninth Circuit. In Lilly v. ConAgra Foods Incorporated, the plaintiff contended that ConAgra violated numerous California laws related to unfair competition and false advertising by failing to disclose the sodium found on the inedible shell of sunflower seeds. 743 F.3d 662 (9th Cir. 2014). In response, ConAgra argued that requiring it to account for the sodium found on the seed shell – which ConAgra claimed was inedible – would improperly impose a state-specific burden above the Nutrition Labeling and Education Act’s requirements.

The Ninth Circuit rejected ConAgra’s argument. The appeals court found that the sodium coating the sunflower seeds’ shells was edible under the FDA’s regulations and should have been included in the label. Just as swiftly, the Ninth Circuit dispatched with ConAgra’s preemption argument, stating that the state law requirements Lilly sought to enforce “are thus no different from federal law and not preempted.” Lilly, 743 F.3d at 665. The appeals court remanded the case to the district court for further proceedings.

Based on Jamie Lewis’s research, more of these lawsuits can be expected. Manufacturers may have more defenses to these lawsuits as they develop. It appears at this time, though, that the Ninth Circuit has seriously impaired any argument that the FDCA preempts state law claims over misleading labels.

In part 2, we’ll look at the second potential front of legal action against spiked protein.